As the Global Financial Crisis (GFC) tightened its grip, the endowment funds of many nonprofits shrunk, with impacts for nonprofits and their relationships with donors. Christopher Thorn reports.
In the years leading up to the GFC, there was unprecedented growth in the number of endowment funds being created by nonprofit organisations, many of which were attracted to invest in Australia’s bullish equity market at the time.
This resulted in many endowment funds becoming heavily weighted towards domestic equities. All too often the risks being adopted did not match the long term objectives of the endowment. With volatility returning to domestic markets in 2008, the GFC saw endowment income drop and capital levels plummet.
Numerous endowments, fearing further losses or seeking to generate funds for operational expenses, sold at the bottom of the cycle. They had adopted a level of risk and an exposure to volatility that could not be sustained in a falling market – a situation that could have been avoided had their long-term objectives and risk tolerances been properly considered in a formal investment strategy.
Endowment outcomes post GFC
The GFC has seen three broad groups of outcomes emerge for nonprofits with endowment funds.
Group 1 – Endowments without an investment policy; or a policy that hasn’t been integrated into the organisation’s overall strategy; or a policy not fully explained and agreed to by major stakeholders (i.e. boards, donors and staff).
An investment policy that is not aligned with the organisation’s mission Investments being made that were not appropriate to the organisation’s financial time frame, risk profile and budget Significant liquidity issues with little or no distinction between operating capital and long-term endowment capital Questioning of investment decisions by stakeholders Scaling back of programs and services because of lack of income Reputational issues and negative publicity Forced selling at the bottom of the market Poorly constructed portfolios unable to fully benefit from improved market conditions
Group 2 – Those that had an investment policy which wasn’t either fully understood by all stakeholders, or which was poorly implemented.
Performance in line with benchmarks in a relative sense but still disappointing to key stakeholders Problems communicating the validity of the investment policy to stakeholders Pressure from stakeholders lacking confidence in the investment policy Reactive manager and/or portfolio changes at inopportune times
Group 3 – Those that had a comprehensive investment policy, well communicated and implemented.
Short term concerns viewed in a strategic context Comfort with existing investments despite negative performance Ability to make informed decisions about performance of investment managers and specific products against agreed benchmarks at opportune points in time Ability to continue acting in line with long-term strategic objectives Ability to adequately communicate investment policy to donors to reassure them that exposure to risk and short-term volatility should be seen in the context of an appropriate long-term investment strategy Able to attract donations through transparency and confidence in the long-term focus of their endowments Lessons from the GFC
The GFC laid bare weaknesses in governance, understanding of risk and the fundamental structures put in place to manage endowments. Those at nonprofits entrusted with the investment of endowment funds, usually board members and trustees, do not always have the expertise to carry out this role.
If there is one lesson those responsible for endowments should take out of the GFC, it is the importance of having a clear long-term investment strategy aligned to the organisation’s mission and supported by robust governance practices.
Endowments and donors – an important dynamic
The importance of having a clear, comprehensive and appropriate investment strategy for an endowment fund cannot be overstated – especially when it comes to inspiring confidence in donors.
A robust investment policy, clearly communicated to donors, is part of the stewardship process. The GFC highlighted the importance of communicating endowment investment strategies to donors and boards, providing confidence in the organisation’s ability to remain on track and achieve its long-term goals. Should an endowment stray from the parameters set out in an investment policy, it can lead to devastating effects in turbulent markets.
These effects can result in catastrophic outcomes such as loss of reputation, loss of donor confidence, permanent capital loss, liquidity constraints and an inability to meet operational commitments.
Seeing philanthropists in a new light
Philanthropists are in a powerful position to demand that the organisations they support adopt quality financial governance practices, promote transparency through the provision of accurate reporting on endowments, and finally, demonstrate expected outcomes.
Whilst the obvious choice is to work with an investment manager, experienced in managing nonprofit endowments; in addition, a nonprofit organisation should not dismiss the value of its own donor base.
With informed and educated philanthropists taking a more involved approach to their giving, those entrusted with managing endowments may find sophisticated donors are willing to share their time and expertise in order to achieve an outcome – an arrangement that can help strengthen the organisation by bringing in valuable skills and experiences, and widening access to the right people and information.